2.1.

1 Activity-based
costing (ABC)

Answers to End-of-chapter questions

2
Cost drivers Totals Overhead allocation rate
Transfer of partly Matons: 3 × 40 000, 170 000 $34 000/170 000,
finished goods i.e. 120 000 i.e. $0.20 per transfer
Cratons: 2 × 25 000,
i.e. 50 000
Quality checks Matons: 4 × 40 000, 310 000 $17 800/310 000,
i.e. 160 000 i.e. $0.06 per check
Cratons: 6 × 25 000,
i.e. 150 000

Overhead allocation:
Matons Cratons
$ $
Transfers 120 000 × $0.20 24 000 50 000 × $0.20 10 000
Checks 28 000 × $0.06   1 680 150 000 × $0.06   9 000
Total overheads 25 680 19 000

4 Selling prices per unit will be as follows.

Maton Craton
$ $
Direct materials 0.5 kg @ $4.20 per kg  2.10 0.75 kg @ $6.40 per kg  4.80
Direct labour 1.5 hrs @ $6.40 per hr  9.60 0.8 hr @ $9 per hr  7.20
Overheads:
 Transfers 3 × $0.20  0.60 2 × $0.20  0.40
 Checks 4 × $0.06  0.24 6 × $0.06  0.36
Total cost 12.54 12.76
Profit margin Cost × 50%  6.27  6.38
Selling price 18.81 19.14

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6 Closing inventory valuations:
Number of units in closing Cost per Inventory
inventory unit valuation
$
Maton 4% × 40 000 = 1 600 $12.54 20 064
Craton 6% × 25 000 = 1 500 $12.76 19 140
Total value of closing inventory 39 204

8 a
Cost drivers Totals Overhead allocation rate
Machine set-ups Hexo: 3 × 500, i.e. 1 500 4 500 $36 000/4 500,
Zaco: 2 × 1 500, i.e. 3 000 i.e. $8 per set up

Quality checks Hexo: 4 × 500, i.e. 2 000 3 500 $14 000/3 500,
Zaco: 1 × 1 500, i.e. 1 500 i.e. $4 per check

Hexo Zaco
$ $
Direct materials 14.00 19.00
Direct labour 11.00 12.00
Overheads: 3 × $8 per unit 24.00 2 × $8 per unit 16.00
set-ups
Overheads: 4× $4 per unit 16.00 1 × $4 per unit  4.00
quality checks
Total cost per unit 65.00 51.00
Selling price per unit 53.00 53.00
Profit/(loss) per unit (12.00)  2.00

b The company is currently making a loss on Hexos and may decide to

discontinue production of this line. The company is making a profit on
Zacos and may consider increasing production of this line.
Before reaching a final decision the directors should consider whether
changes can be made in the production process of Hexos that will reduce
the overhead costs of this product and make it profitable. They might also
consider whether the selling price of Hexos can be increased despite the
information about competitors, based on the quality of Hexos compared
to rivals’ products, or some other distinct features. If they decide to
discontinue production, they will need to consider whether there is any
additional demand for Zacos which the company could meet to use up
the unused labour and machine time. They may consider that reducing
the price of Zacos by a small amount could increase demand to some
extent to justify extra production. In addition, the directors need to
consider whether the company will lose customers who buy both Hexos
and Zacos, because these consumers will feel their needs are not being
met if production of Hexos is discontinued.

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 Budgeting and
2.2.1 budgetary
control
Answers to End-of-chapter questions
2 School: sales budget as a school does not sell a product or a service.
Firm of accountants: trade payables budget as the firm is not likely to make
purchases on credit.
Leisure complex: trade receivables budget as leisure complex does not provide
facilities on credit.
High street butcher: production budget as a butcher does not manufacture
a product.
4 Cash budget: to identify periods when it will be necessary to apply for a bank
overdraft; to identify periods when there is a large surplus balance that could
be used more effectively.
Production budget: to identify production levels arising from forecast sales
and from expected levels of inventory; to identify periods when required
production levels are not attainable (or periods when there is unused
production capacity) in time for remedial action to be taken.
Trade receivables budget: to forecast amounts owed by credit customers at the
end of each month (or budget period) linked to the sales budget; to identify
the amounts expected to be received from credit customers each month (or
budget period) linked to the cash budget.
6 Labour budget: to identify the labour hours required to meet production
linked to the production budget; to identify periods when there might be
a labour shortage or insufficient labour to meet requirements in time for
remedies to be put in place.
Trade payables budget: to identify the amount due to credit suppliers at the
end of each month (or budget period) linked to the purchases budget; to
identify the amounts to be paid to credit suppliers each month (or budget
period) linked to the cash budget.
Master budget: to identify the forecast profit or loss for the period which will
result from the plans implemented in the other functional budgets; to provide
the basis for establishing whether the business’s strategic objectives are met if
current plans are carried out.

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8 a
Sales budget for each of four months ending 31 January 2017
October November December January
Sales units 250 300 390 180
Sales value ($) 2000 2400 3120 1440

b Production budget for each of four months ending 31 January 2017

units October November December January
Opening inventory 0 60 78 36
Sales 250 300 390 180
Closing inventory 60 78 36 36
Production 310 318 348 180

c Material purchases budget for each of four months ending 31 January 2017
October November December January
Production units 310 318 348 180
Materials cost ($2 per unit)($) 620 636 696 360

d Trade receivables budget for each of four months ending 31 January 2017
October November December January
Opening balance b/f 0 1000 1600 2040
Sales (credit) (50% of total sales) 1000 1200 1560 720
Receipts (one month’s credit) 0 (600) (720) (936)
Receipts (two months’ credit) 0 (400) (480)
Closing balance c/f 1000 1600 2040 1344

e
Trade payables budget for each of four months ending 31 January 2017
October November December January
Opening balance b/f 465 477 522
Credit purchases (75% of total purchases) 465 477 522 270
Payments 0 (465) (477) (522)
Closing balance c/f 465 477 522 270

f Cash budget for each of four months ending 31 January 2017

October November December January
$ $ $ $
Receipts
Capital introduced 2 000
Cash sales (W1) 950 1140 1482 684
Trade receivables 0 600 1120 1416
Total receipts 2 950 1 740 2 602 2 100

Payments
Cash purchases (W2) 152 156 171 88
Trade payables 0 465 477 522
Overheads 520 520 520 520
Drawings (W3) 475 570 741 342
Total payments 1147 1711 1909 1472
Net cash flow 1 803 29 693 628
Opening balance brought forward 0 1 803 1 832 2 526
Closing balance carry forward 1 803 1 832 2 526 3 154

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Total
W1 Cash sales
Cash sales per month (50% sales) 1000 1200 1560 720
Receipts (95%) 950 1140 1482 684
Discount allowed (5%) 50 60 78 36 224

W2 Cash purchases
Cash purchases per month (25% 155 159 174 90
purchases)
Cash paid to trade payables (98%) 151.9 155.8 170.5 88.2
Discount received (2%) 3.1 3.2 3.5 1.8 11.6

W3 Closing balance before deduction of 950 1 140 1 482 684

drawings

g
Master budget
Forecast income statement for the four months ended 31 January 2017
$ $
Revenue (1 120 units × 8) 8 960
Less: Opening inventory 0
Purchases of materials 2 312
Closing inventory (36 units at cost $2) (72)
Cost of sales (2 240)
Gross profit 6 720
Add discounts received 12
6 732
Less discounts allowed 224
Overheads 2 080
(2 304)
Profit for four months 4 428

Statement of financial position at 31 January 2017

$ $
Current assets
Inventory 72
Trade receivables 1 344
Cash at bank 3 154
4 570
Capital
Original investment 2 000
Add profit for four months 4 428
6 428
Less drawings (2 128)
4 300
Current liabilities
Trade payables 270
4 570

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10 Workings
June July August September October
Purchases (units) 60 80 120 100 80
$ $ $ $ $
Total purchases ($) 750 1000 1500 1250 1000
Cash payments (25%) 187.5 250 375 312.5 250
Purchases on credit 562.5 750 1125 937.5 750
One month’s credit (60%) 450 600 900 750 600
Two month’s credit (15%) 112.5 150 225 187.5 150

Trade payables budget for each of the three months ending 31 October
August September October
$ $ $
Opening balance b/f 862.5 1 275.0 1 162.5
Credit purchases 1 125.0 937.5 750.0
Payments (one month’s credit) (600.0) (900.0) (750.0)
Payments (two month’s credit) (112.5) (150.0) (225.0)
Closing balance c/f 1 275.0 1 162.5 937.5

12 a Alexon Ltd
Cash Budget for each of three months ending June 2016
April May June
$ $ $
RECEIPTS
Cash sales (W1) 4 500 7 200 9 000
Trade receivables (W1) 7 980 9 975 15 960
Issue of shares 15 000
Total receipts 12 480 17 175 39 960
PAYMENTS
Credit purchases (W2) 4 800 6 000 9 600
Operating expenses 2 100 2 100 2 100
Tax due 12 000
Non-current assets 8 000
Directors’ salaries 6 000 6 000 6 000
Interim dividend (W3) 7 500
12 900 34 100 25 200
Net cash flow (420) (16 925) 14 760
Balance brought forward (18 700) (19 120) (36 045)
Balance carry forward (19 120) (36 045) (21 285)

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 W1 Receipts from sales
March April May June
$ $ $ $
Total sales 12 000 15 000 24 000 30 000
Cash sales (30%) 3 600 4 500 7 200 9 000
Credit sales (70%) 8 400 10 500 16 800 21 000
Receipts from credit
sales (i.e. less 5%) 7 980 9 975 15 960 19 950

W2 Purchases
Purchases (40% × Sales) 4 800 6 000 9 600 12 000

W3 Interim dividend
Issue shares 50 000 × dividend 0.15,
i.e. $7 500

b Possible advice on how to improve the company’s liquidity:

uuImprove sales.
uuRestrict credit terms to fewer trade receivables.
uuCancel discount allowed to trade receivables.
uuBring forward share issue to April or May.
uuFind cheaper supplier.
uuSeek discounts from suppliers.
uuMake efficiencies in business operating expenses, reduce directors’ monthly salaries.
uuPostpone purchase of non-current asset.
uuReduce amount of interim dividend or cancel interim dividend.
14 a Shafiq
Production budget for each of the five months ending July
March April May June July
Sales 16 16 28 40 40
Opening inventory 0 24 48 60 44
Closing inventory 24 48 60 44 28
Production 40 40 40 24 24

b Cash budget for each of the five months ending July

March April May June July
$ $ $ $ $
RECEIPTS
Cash sales 2 560 2 560 4 480 6 400 6 400
Total receipts 2 560 2 560 4 480 6 400 6 400
PAYMENTS
Variable overheads 3 400 3 400 3 400 2 040 2 040
Mosad’s wages 800 800 800 0 0
Fixed overheads 500 500 500 500 500
Drawings 60 0 0 1 500 3 860
4 760 4 700 4 700 4 040 6 400
Net cash flow (2 200) (2 140) (220) 2 360 0
Balance brought forward 3 200 1 000 (1 140) (1 360) 1 000
Balance carry forward 1 000 (1 140) (1 360) 1 000 1 000

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16 a Production budget for each of periods 1–3
Units
Period 1 Period 2 Period 3
Sales 14 500 15 200 16 100
Opening inventory (2 900) (3 040) (3 220)
Closing inventory 3 040 3 220 3 480
Production 14 640 15 380 16 360

Workings
W1 closing inventory covers 4 days; one period is 4 × 5 days (i.e. 20 days)
so closing inventory is 1/5 of next period’s sales

b Comparative income statements (trading section) for periods 1–3

Budgetary control Fixed production
$ $ $ $
Revenue (45 800 × $1.45) 66 410 66 410
Opening inventory (2 900 units) 1 740 1 740
Production (46 380 units × 60¢) 27 828
Production (54 000 units × 60¢) 32 400
29 568 32 400
Closing inventory (3 480 units) (2 088)
Closing inventory (11 100 units) (6 660)
(27 480) (25 740)
Gross profit 38 930 38 930

c Improved cash flow as lower production costs each month.

Reduced storage required for closing inventory, reducing costs.

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 2.3.1 Standard
costing

Answers to End-of-chapter questions

2
Standard cost: 4.25 hrs @ $6.20 = $26.35
Total variance $
5 800 units should cost (x $26.35) 152 830
Actual cost (25 520 hrs × $160 776/25 520, i.e. × $6.30) 160 776
Total variance 7 946 Adverse

Rate variance $
25 520 hours should cost (× $6.20) 158 224
Actual cost of 25 520 hours 160 776
Rate variance 2 552 Adverse

Efficiency variance
5 800 units should take (× 4.25 hrs) 24 640 hrs
Actual hours used 25 520 hrs
Efficiency variance 870 × $6.20
i.e. $5 394 Adverse

4 Materials variances
Notes:
Standard: 5 200 units × 7m × $5.75 = $209 300
Actual: 5 200 units × 6.5m × $5.85 = $197 730

Price variance $
Standard: 5 200 × 6.5m (i.e. 33 800m) × $5.75 194 350
Actual cost: 5 200 × 6.5m × $5.85 197 730
Price variance 3 380 Adverse

Usage variance
5 200 units should use 7m 36 400m
Actual use was 33 800m
Usage variance 2 600m × $5.75
i.e. 14 950 Favourable

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 Labour variances
Notes:
Standard: 5 200 units 1.5 hrs (i.e. 7 800 hrs) × $5.60 = $43 680
Actual: 8 060 hrs × $5.50 = $44 330

Rate variance $
8 060 hours should cost (× $5.60) 45 136
Actual cost 44 330
Rate variance 806 Favourable

Efficiency variance
5 200 units should take (× 1.5 hrs) 7 800 hrs
Actual time taken 8 060 hrs
Efficiency variance 260 hrs × $5.60
i.e. 1 456 Adverse

6 Materials variances
Notes:
Standard: 1 860 × 8.5 kg (i.e. 15 810 kg) × $1.80 = $28
458
Actual: 1 860 × 8 kg (i.e. 14,880 kg) × $1.75 = $26 040

Price variance $
Standard: 14 880 kg should cost (× $1.80) 26 784
Actual cost was 26 040
Price variance 744 Favourable

Usage variance
1 860 units should use × 8.5 kg 15 810 kg
Actual use was 14 880 kg
Usage variance 930 kg × $1.80
i.e. 1 674 Favourable

Labour variances
Notes:
Standard:1 420 units 0.75 hrs (i.e. 1 395 hrs) × $8 = $11 160
Actual: 1 420 hrs × $8.20 = $11 644

Rate variance $
1 420 hrs should cost (× $8) 11 360
Actual cost 11 644
Rate variance 284 Adverse

Efficiency variance
1 860 units should take 1 394 hrs
Actual time taken 1 420 hrs
Efficiency variance 25 hrs × $8
i.e. 200 Adverse

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 Sales variances
Sales volume variance
Standard quantity 1500 units
Actual quantity 1750 units
Volume variance 250 × $32
i.e. $8 000 Favourable

Sales price variance $

Actual sales at standard price, 1 750 × $32 56 000
Actual sales at actual price 60 375
Sales price variance 4 375 Favourable

8 $
Budgeted direct cost 84 550
Direct materials price variance 2 140 Adverse
Direct materials usage variance (1 280) Favourable
Direct labour rate variance (2 205) Favourable
Direct labour efficiency variance (4 655) Adverse
Actual direct cost 87 860

10 Workings:
The overhead absorption rate is budgeted fixed overheads $84 000/12 000 hrs, i.e. $7 per hour

Fixed overhead total variance

Actual fixed overheads ($81 300) − actual standard hours (11 200) × absorption rate ($7)
i.e. $78 400
i.e. $2 900 adverse

Fixed overhead expenditure variance

Actual expenditure ($81 300) − budget expenditure ($84 000)
i.e. $2 700 favourable

Fixed overhead volume variance

Actual standard hours less budget hours (i.e. 11 200 − 12 000) × Absorption rate ($7)
i.e. $5 600 adverse

Fixed overhead efficiency variance

Difference in actual and standard hours (200 hrs) × Absorption rate ($7)
i.e. $1 400 Favourable

Fixed overhead capacity variance

Difference between actual hours and standard hours (1 000) × Absorption rate ($7)
i.e. $7 000 adverse

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 2.4.1 Investment
appraisal

Answers to End-of-chapter questions

2 a Payback
Advantages:
uuIt is relatively easy to use − calculations are straightforward, the
concept is widely understood, so it is often used.
uuIt places an emphasis on cash flows which are regarded as more significant
these days. In particular it recognises the importance of the earliest cash
flows to which less risk is attached, rather than those that come later.
Disadvantages:
uuIt ignores the time value of money (although it is possible to calculate
payback based on discounted cash flows); it disregards net cash flows
that occur after the payback date which can rule out very successful
projects that have a long life bringing in net cash inflows long after the
payback point.
uuIt ignores the fact that patterns of cash flows can vary, which may
disadvantage a project that takes time to generate cash flows but that
ultimately has large net cash inflows.
b Accounting rate of return (ARR)
Advantages:
uuIt is relatively easy to use.
uuIt is possible to compare a project’s results with the business’s recent
profitability.
uuIt takes account of the total earnings of the project.
Disadvantages:
uuIt ignores the time value of money.
uuIt ignores the timing of cash flows.
uuIt uses profit rather than cash in calculations and profit is less certain.
c Internal rate of return (IRR)
Advantages:
uuIt takes account of the time value of money.
uuIt takes account of all cash flows throughout the life of the project.
uuIt places more emphasis on earlier cash flows.

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 Disadvantages:
uuIt is a more complex method to use than payback or ARR.
uuIt is difficult to predict the life of many projects.
uuCash flows are also difficult to predict.
uuThe cost of capital may vary over the lifetime of the project.
uuIt requires an element of trial and error and is not 100 per cent
accurate.
d Net present value (NPV)
Advantages:
uuIt takes account of the time value of money.
uuIt takes account of all cash flows throughout the life of the project.
uuIt places more emphasis on earlier cash flows.
Disadvantages:
uuIt is a more complex method to use than payback or ARR.
uuIt is difficult to predict the life of many projects.
uuCash flows are also difficult to predict.
uuThe cost of capital is critical in all the calculations, yet this may be difficult
to determine; the cost of capital can vary over the lifetime of the project.
uuIt should not be used in isolation: other factors such as poor payback
or social accounting factors should also be considered.
4 a Discounted payback
Year Net cash flow Discount
Factor NPV
$ 14% $
0 (100 000) 1.000 (100 000)
1 40 000 0.877 35 080
2 45 000 0.769 34 605
3 50 000 0.675 33 750

Payback based on present values using the company’s cost of capital

is 2.898 years (i.e. 2 years plus 30 315/33 750) or 2 years 328 days

b Internal rate of return

Net present values based on two discount factors
(one to give negative result; one to give positive result)
Year Net cash flow Discount Discount
Factor NPV Factor NPV
$ 12% $ 20% $
0 (100 000) 1.000 (100 000) 1.000 (100 000)
1 40 000 0.893 35 720 0.8333 33 332
2 45 000 0.797 35 865 0.694 31 230
3 50 000 0.712 35 600 0.579 28 950
Net present value(s) 7 185 (6 488)

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 IRR = 12 + [(20 − 12) × 7 185/(7 185 + 6 488)]
= 12 + (8 × 7 185/13 673)
= 12 + (8 × 0.525)
= 12 + 4.2
= 16.20%

c The managers of Patel plc should undertake the project based on financial
grounds, as the internal rate of return (16.20%) is higher than the cost
of capital (14%) and the project pays for itself (just) within its three-year
lifespan.
6 a

Calculation of net cash flows

Units Inflows Outflows Net cash flow
produced
$ $ $
0 (200 000) purchase of machine (200 000)
1 2 600 117 000 × $45 62 400 × $24 54 600
2 4 500 202 500 × $45 108 000 × $24 94 500
3 5 400 315 900 × $58.5 212 000 × $30 103 900
(+ maintenance $50 000)
4 6 480 492 804 × $76.05 243 000 × $37.5 249 804

b Payback period is Year 2 + 50 900/103 900, i.e. 2.48 years or 2 years

179 days.
Discounted payback period
Calculation of discounted cash flows
Year Net cash- Discount NPV
flows factor
$ 14%
0 (200 000) 1.000 (200 000)
1 54 600 0.877 47 884.2
2 94 500 0.769 72 670.5
3 103 900 0.675 70 132.5
4 249 804 0.592 147 883.96

Discounted payback is Year 3 + 9312.8/147 883.96, i.e. 3.06 years or

3 years 23 days.
c Average rate of return
Average investment is $100 000 (i.e. $200 000/2)
Calculation of average profit
Year NCF Dprcn Profit
1 54 600 50 000 4 600
2 94 500 50 000 44 500
3 103 900 50 000 53 900
4 249 804 50 000 199 804
Total profit 302 804

Average profit is total profit ($302 804)/4 i.e. $75 701

Rate of return:
75 701/100 000%, i.e. 75.70%

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 d Net present value is $138 610 (see table for discounted cash flows).
e Internal rate of return
Year Net cash- Discount NPV Discount NPV
flows factor factor
$ 12% 40%
0 (200 000) 1.000 (200 000.00) 1.000 (200 000.00)
1 54 600 0.893 48 757.80 0.714 38 984.40
2 94 500 0.797 75 316.50 0.510 48 195.00
3 103 900 0.712 73 976.80 0.364 37 819.60
4 249 804 0.636 158 875.34 0.260 649 65.94
156 926.44 (10 035.06)

Internal rate of return =

 12 + [(40 − 12) × 156 926.44/(156 926.44
+ 10 035.06)
i.e. 12 + (28 × 0.9401436)
i.e. 12 + 26.32
i.e. 38.32%
f The manager of Roberts Ltd should purchase the new machine on
financial grounds because the investment will pay for itself within the
lifetime of the investment. The investment has a positive net present value
and a high rate of return.

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 Topic 2: Cost and management
accounting
Answers to exam-style questions
2 a
i Direct material price variance: (852 × 6.25) − 5010 = $315 Favourable
 [2 marks]
ii Direct material usage variance: (210 × 4) − 852 = 12 × 6.25 = $75 Adverse
 [2 marks]
iii Direct labour rate variance: (770 × 8) − 6468 = $308 Adverse
 [2 marks]
iv Direct labour efficiency variance: (210 × 3.5) − 770 = 35 × 8 = $280 Adverse
 [2 marks]
b

Standard cost 210 units 11 130

Variances (315 F, 75 A, 308 A, 280 A) 348 A
Actual cost (5 010 + 6 468) 11 478

 [7 marks]
c
uuFavourable price variance suggests material could be of lower quality.
uuAdverse usage variance could be due to waste of lower-quality
material.
uuAdverse labour rate variance could be due to overtime as a result of
lower-quality material.
uuAdverse efficiency variance could be due to having to rework furniture
due to lower-quality material.
 [6 marks]
d
uuProvides a yardstick for performance evaluation.
uuIdentifies variances leading to corrective actions.
uuMinimises wastage.
uuActs as a tool for planning and budgeting.
uuProvides information for inventory valuation.
uuFacilitates responsibility accounting.
uuFocuses the organisation on cost control.
uuProvides a basis for incentive schemes.  [4 marks]

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 4 a
Cash budget
June July August Sept
$ $ $ $
Receipts
Trade receivables 35 960 41 800 45 340 41 700
Payments
Suppliers 17 775 23 700 21 725 17 775
Wages and salaries 6 000 6 000 8 000 6 000
Variable overheads 4 800 4 000 5 600 4 800
Fixed overheads 6 000 8 400 7 200 6 000
Taxation 5 000
Non-current assets 15 000 9 000
Total payments 34 575 57 100 42 525 48 575
Net cash flow 1 385 (15 300) 2 815 (6 875)
Opening balance (2 100) (715) (16 015) (13 200)
Closing balance (715) (16 015) (13 200) (20 075)

 [13 marks]
b
uuImprove credit control to eliminate irrecoverable debts.
uuImprove credit control to encourage speedier settlement of customer
accounts.
uuNegotiate better settlement terms with suppliers.
uuDelay purchase of non-current assets.
uuArrange alternative finance for non-current assets.  [4 marks]
c
uuEnsures co-ordination of all activities of the business.
uuIdentifies limiting factors in advance.
uuMotivates managers when they are involved in the budget-setting
process.
uuAvoids management by crisis.
uuFacilitates responsibility accounting.  [4 marks]
d
uuCan act as a straightjacket.
uuReduces initiative and innovation.
uuLack of participation may demotivate employees.
uuCan create competition for resources amongst managers.  [4 marks]

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